The RBA and most
conventional market economists see 2011 as the year in which our biggest
challenge will be “managing prosperity”. The mining boom will
keep the money flowing, and the economy will just have to cope with the
structural change that results.
There’s no doubt
that China’s demand for our minerals has generated enormous revenue for
the country, by giving us the best terms of trade in the last half century,
and turning our trade balance into surplus.
If these were the only
forces determining our future, then the expectation that our major economic
problem in the future will be inflation driven by supply constraints (mainly
labour shortages leading to a wages breakout) could well be correct.
But there are also the
forces of credit.
The “managing
prosperity” crowd failed to consider these prior to the Global
Financial Crisis, which is why they didn’t see it coming while a handful of non-orthodox
economists did—including yours
truly (Bezemer 2009; Bezemer 2010; Fullbrook 2010).
If these forces had been
tamed, then good times could well lie ahead. Equally, if they had turned
decidedly positive again—so that credit growth was boosting the economy
rather than slowing it down—then boom times could be in the offing,
though with an inevitable day or reckoning still in the future as our debt to
GDP level mounted.
When I predicted the GFC,
I was relying on the ratio of private debt to GDP and its growth rate as
indicators of a looming economic crisis. In both Australia and most of the
OECD, debt to GDP levels had been rising exponentially, turbo-charging
aggregate demand; it was to me (and many other non-neoclassical economists)
all too evident that, at some stage, this growth of private debt would have
to cease. When it did the mere fact that its rate of growth had slowed would
cause a major recession.
That turnaround in the
private debt to GDP ratio that I first predicted in 2006 commenced in 2008,
and the slowdown in the rate of growth of debt that preceded the peak was the
key force behind the financial crisis that began in late 2007.
The economic crisis that
ensued was as big as I expected, though its severity has been attenuated by
the largest government stimulus programs in human history. However the
Australian economy performed far better than I expected, and it could be
argued—and has been argued to my face—that I got it wrong about
Australia.
I certainly got the
empirical predictions wrong. I expected that unemployment would hit double
digits here, as it has elsewhere in the OECD (the US figure of below 10
percent reflects its peculiar unemployment scheme plus undercounting of
discouraged workers). Instead, it peaked at 5.8% and has since fallen to
5.2%.
It would appear that
there are two possible interpretations of this: either Australia really was
different, and economic principles that apply to the rest of the globe
don’t apply here, or my underlying model of how a market economy works
was wrong.
Option 2 was unlikely
since the credit-driven, Hyman Minsky grounded approach I’ve always
taken to economics did predict the crisis, and in the rest of the OECD it
remains a deep and seemingly intractable crisis. So was Australia just the exception
that proves the rule?
No. In fact, the data
supports a third option: that Australia’s position as a minerals
exporter to China does make it somewhat different, but the fundamental model
of a credit-driven economic cycle applies here too. It’s just that a
peculiarly Australian government policy—the First Home Vendors
Scheme—turned the credit engine to our favour during the GFC. Whereas
the rest of the developed world became mired in deleveraging, we leveraged
our way back towards prosperity.
Private debt has gone
from rising by US$4.5 trillion in the USA—thus adding $4.5 trillion to
aggregate demand—to falling by $2.5 trillion, and thus subtracting from
aggregate demand there. This was the factor that drove the US from boom to
near-Depression.
But though Australia
began the deleveraging process, it stalled it just as the change in debt
approached zero. The increase in debt since then has been a major factor in
why our unemployment rate stopped increasing, and has since fallen.
The common factors
driving the two economies (and therefore the difference in their economic
outcomes to date) is starkly evident when one considers the “credit
impulse”—or the rate of acceleration of debt. The turnaround from
accelerating debt propelling the change in aggregate demand to
decelerating—falling—debt subtracting from the change in
aggregate demand was the greatest the US has ever experienced, since and
including the Great Depression.
The reversal of this debt
deceleration is also evident in that chart of course—and the
commensurate slowdown in the rate of the increase in unemployment. Government
policy clearly played a large role in this—the private sector was
hell-bent on deleveraging before the US’s massive fiscal stimulus and
QE1.
Now check out
Australia’s story over the same time period—and at the same
scale. We got out of the crisis before we really got into it by reversing the
private sector’s trend to deleveraging, and encouraging borrowing once
more.
Can we keep on borrowing
our way to prosperity? Here’s where I turn cynic once more: we could,
if we didn’t already have an unprecedented level of private debt, with
both households and businesses carrying more debt than they’ve ever
sustainably carried in the past.
This implies a limit to
the credit impulse (both in Australia and overseas). For the credit impulse
to remain positive, then ultimately the debt to GDP ratio must start rising,
and keep rising. But with the economy so heavily indebted already, the credit
impulse is likely to peter out and give way to decelerating debt once more—with
a negative impact upon aggregate demand.
This is already starting
to turn up in the data. The credit impulse graphs so far consider the change
in the change in debt over a year; this next graph considers the acceleration
in debt on a month by month basis as well. Though the monthly data is very
volatile, only 3 of the last ten months’ credit impulses have been
positive.
This indicator tends to
lead changes unemployment by about three months. A sustained run of negatives
could be enough to generate yet another “unexpected” increase in
unemployment next year.
This returns me to the
bottom line of my credit-oriented analysis. Sustained recoveries from
recessions in Australia and the whole OECD in the last 40 years have all been
accompanied by rising levels of private debt to GDP. I simply don’t
believe that’s possible now.
When the Australian
economy has hit the skids in the past, the recoveries that ensued – in
1975, 1983 and 1993 – were all accompanied by increases in borrowing.
Credit growth boosts investment and job creation, and everyone’s happy.
Happiness of the debt-financed kind will be short-lived in 2011, because
we’re already past the peak level of debt that we’ve ever had, or
are likely to have.
So I expect Australia to
resume deleveraging during 2011, leading to recession-like conditions in
sectors that are not major beneficiaries of the China Boom. We are already
seeing the first casualty – retailers are discounting well before
Christmas, rather than after it, and the “unexpected” drop in
retail sales last month is something I expected to see when the First Home
Vendors Boost wore off. Retailers’ pain will only increase through
2011.
My advice to the
optimists is to take their eyes of China for a few minutes and take a good
hard look at the direction credit aggregate data is moving – it’s
down, and unfortunately that’s where two thirds of the
Australia’s “three-speed economy” could well move next
year.
Lastly, let’s also
take a slightly longer term look at the relationship between our exports and
imports. We are certainly benefiting from positive net exports right now. But
history’s lesson is that that boost can disappear very quickly.
Steve Keen
DebtDeflation
Steve Keen is associate professor at the University
of Western Sydney School of Economics and Finance. As an economist, he does
something very unusual : he treats money seriously, and as a result he gets a
very different result on how the economy operates.
